"The four per cent duty might be perceived as an irritant but arguably it cannot be the cause for smuggling. Its avoidance may not be lucrative enough for smugglers to take risks"

For a variety of reasons Indians have an insatiable appetite for gold. The demand, however, has to be met mostly by imports since domestic production is minimal. Last year, Indians imported a record 958 tonnes of gold. The restrictions and controls to curb consumption of gold have been in existence for one reason or the other. When the president of India promulgated a proclamation of emergency on October 26, 1962 under Clause (1) of Article 352 of the Constitution of India, he also promulgated the Defence of India Ordinance. In pursuance of the powers given by the Ordinance, Defence of India Rules, 1962 were framed. This led to the notification of the "Gold Control Rules, 1963". Every person, other than a dealer, was required to make a declaration, within 30 days from the commencement of the rules or within a period specified by a central government notification, to the Gold Control Administrator the quantity, description, or other particulars of the gold he owned. The rules also laid down that any person in possession or control of gold, other than ornaments, will be presumed, until the contrary is proved, to be the owner.

Subsequently, Parliament enacted the Gold (Control) Act, 1968 to provide, in the economic interest of the community, for the control of production, manufacture, supply, distribution, use and possession of, and business in, gold, ornaments and articles of gold. The Act was repealed on June 6, 1990.

The pre-1991 era of India's trade policy was marked by a regime of restrictions, controls, permits and licenses. The import policy was largely driven by foreign exchange scarcity. The import of gold was prohibited, except for use by jewellery exporters. History has it that this led to large-scale smuggling of gold into India and the 1960s and 1970s saw the emergence of notorious names in smuggling who gave customs and other anti-smuggling agencies a tough time.

It was only after economic reforms began and foreign exchange reserves became somewhat comfortable that the import of gold was liberalised. Announcing the paradigm shift in the policy towards import of gold, the finance minister said in his Budget Speech (1992-93): "I have already mentioned that import of gold by Indians including persons of Indian origin as part of their baggage will now be allowed. Every such passenger will be allowed to bring up to five kilograms of gold and the import duty on such gold will be Rs 450 per 10 gms... I am confident that this step will be welcomed by all, except those engaged in the hitherto profitable business of smuggling this metal into the country."

The initiative almost brought gold smuggling to a grinding halt. In the past 20 years, the duty rate has changed several times but always retaining its non-ad valorem character. Significantly, no change touched the introductory level of Rs 450. It was only in January 2012 that the government switched from specific to ad valorem duty - from Rs 300 per 10 gms to two per cent. In the recent Budget, the rate has been increased to four per cent. True, within a span of two months the duty on gold has increased almost four times. One can, therefore, seriously ask the question: would this increase encourage smuggling?

Such apprehension has its roots in the past when smuggling was rampant. However, the reason for smuggling in those days was different. The reason was not the customs duty. The reason was the import policy. An import ban put a huge premium on gold. People were prepared to pay any price for gold. The four per cent duty might be perceived as an irritant but arguably it cannot be the cause for smuggling. Its avoidance may not be lucrative enough for smugglers to take risks, more so when the modern tools of collecting intelligence and the technology available with customs and other agencies would render attempts to smuggle highly vulnerable. It also needs to be noticed when the duty was imposed in 1992, the ad valorem incidence of specific duty imposed on gold was about 15 per cent - much more than the present four per cent. Did it lead to any large-scale smuggling then?

"By considering gold an unproductive asset, the government will push this demand out of the formal sector since there are no other instruments that provide all the advantages that gold offers"

In the first three months of 2012, the government raised the customs duty on gold not once but twice, taking it from approximately 0.5 per cent to a comparatively massive four per cent. This was first done in mid-January when tariffs were increased from a flat Rs 300 per 10 gm to two per cent of the value, and then in the Budget, when the duty was doubled to four per cent.

Though the industry took the first increase in its stride, the doubling of duty in the Budget has come as a rude shock. The impact will probably be exactly the opposite of the intention - rather than adding revenue for the government, it will encourage illegal gold imports and boost the parallel economy.

We all know that gold is a deep-rooted part of our cultural heritage. It also serves as a highly liquid form of savings and a hedge against inflation, having appreciated much faster than other asset classes. Naturally, we cannot expect this demand to suddenly disappear. And, since India produces virtually no gold, demand has to be met entirely through imports - legal or illegal!

Experience shows that in the years when the Gold Control Act banned dealings in gold, smuggling became rampant. But, ever since liberalisation began with the abolition of the Act in 1992, and a nominal customs duty was levied, almost the entire consumption of gold was channelled through the banking sector or government-nominated agencies.

A quick look at figures shows that in terms of volumes there has not been a major increase in consumption. In 2007, India consumed 642 tonnes of gold for jewellery, and 362 tonnes as investment; in 2011, the corresponding figures are 574 tonnes and 342 tonnes respectively. The increase has been in value terms, due almost entirely to the escalation in price.

By considering gold an unproductive asset, the government will only push this demand out of the formal sector since there are no other established instruments that provide all the advantages that gold offers to the consumer-investor.

Now that India will have one of the highest import tariffs (among countries that consume significant amounts of gold), there will be a significant difference between the international and Indian prices. This difference may encourage illegal imports.

It could also create other distortions - gold could be brought into the country as "jewellery" via countries like Thailand with special duty rates, and then melted and resold as bars or coins.

In fact, hoping to curb the scourge of black money and a parallel economy by taxing gold imports is akin to a surgeon treating the symptoms without tackling the cause.

Apart from the possibility of increased smuggling, the additional levy of excise duty on unbranded jewellery as well as the need to deduct a one per cent tax collected at source on all transactions above Rs 2 lakh will push the sector back to the "licence raj" era.

Since the liberalisation in the 1990s, the formerly unorganised jewellery retail sector has moved towards greater transparency and professional management practices. The proof lies in the significant increase in the revenue collection by state governments. The jewellery sector is not shirking it responsibility and is willing to contribute to the exchequer through the imposition of nominal duties. But it is very concerned about handling one more regulatory authority, that is, the excise officials, and the paperwork and resources that will be involved in collecting duty since manufacturing jewellery is a unique and complex process with multiple stages.

A balance could be achieved by creating appropriate instruments that will satisfy the Indian consumers' desire to maintain some of her savings in gold. The Gold Savings Accounts that have been operated by Indian banks could provide the answer, with some minor changes in operations. Without going into details, let me say the instrument should permit households who are buying gold jewellery and coins in a physical form for their future needs to make purchases and hold the gold with banks, which then lend it to jewellers for jewellery production. In this way, the needs of the consumer, the industry and the government can all be easily met.